AC221 Ch.10 Stockholders Equity

Why do companies issue stock dividends?

-To continue dividends but conserve cash -To reduce the per-share market price of its stock

When reporting stockholders' equity on a balance sheet, a corporation lists its accounts in this order

-preferred stock -common stock -additional paid-in capital -retained earnings

Dividends on Preferred Stock

-preferred stockholders receive dividends first -stated as a percent of par value, or -stated as a dollar amount per share

Three main ways to finance an asset purchase:

-through profitable operations -by issuing equity (stock) -by issuing bonds (or notes) payable

Three relevant dates for dividends

1) the declaration date 2) the date of record 3) the payment date

Advantages of a Corporation

1. Can raise more capital than a propreitorship or partnership can 2. Continuous life 3. Ease of transferring ownership 4. Limited liability of stockholders

Common Stock: 1. Obligation to repay principal 2. Dividends/interest 3. Obligation to pay dividends/interest

1. No 2. Dividends are not tax-deductible 3. Only after declaration

Preferred Stock: 1. Obligation to repay principal 2. Dividends/interest 3. Obligation to pay dividends/interest

1. No 2. Dividends are not tax-deductible 3. Only after declaration

Stockholders' Equity

1. Paid-in Capital (contributed capital) 2. Retained earnings

Disadvantages of a Corportation

1. Separation of ownership and management 2. Double taxation of distributed profits 3. Government regulation

Why do corporations purchase their own stock?

1. The company has issued all its authorized stock and needs some stock to distribute to employees under stock purchase plans or compensation plans. 2. The business wants to increase its net assets by buying its stock low and hoping to resell it for a higher price. 3. Management wants to avoid a takeover by an outside party 4. Management wants to increase its reported earnings per share of common stock (net income / number of common shares outstanding). 5. Management wants to use a repurchase program to return excess cash to shareholders who are willing to sell their shares back to the company as an alternative to receiving a cash dividend.

Stockholders' Rights

1. Vote 2. Dividends 3. Liquidation 4. Preemption

Long-Term Debt: 1. Obligation to repay principal 2. Dividends/interest 3. Obligation to pay dividends/interest

1. Yes 2. Interest expense is tax-deductible 3. At fixed rates and dates

A company neither __________ nor __________ when it sells stock to, or buys its stock from, its own stockholders.

1. earns a profit 2. incurs a loss

Difference between CREDIT and DEBIT balance in Retained Earnings

A CREDIT balance is normal, indicating that the corporation's lifetime earnings exceed its lifetime losses and dividends. A DEBIT balance, which is called a deficit, arises when a corporation's lifetime losses and dividends exceed its lifetime earnings. Deficits are subtracted to determine total stockholders' equity.

Separate Legal Entity

A corporation is a distinct entity that has many of the rights that a person has. A corporation can buy, own, and sell property; own assets and liabilities; and enter contracts, sue, and be sued.

Retirement of Treasury Stock

A corporation purchases its own stock and retires it by cancelling the stock certificates. Once retired stock cannot be reissued. Neither total assets nor total liabilities are affected. The entry is made by decreasing the number of shares issued in stockholders' equity.

Dividend

A distribution by a corporation to its stockholders, usually based on the company's earnings. They usually take three forms: cash, stock, and noncash assets

Stock Dividends

A proportional distribution by a corporation of its own stock to its stockholders. They increase the Common Stock account, the Paid-in Capital in Excess of Par-- Common, and decrease Retained Earnings. Total equity is unchanged and no asset or liability is affected.

No-Par Common Stock w a Stated Value

Accounting for a no-par stock with a stated value is identical to accounting for par-value stock. The excess paid over the stated value is credited to Addition Paid-in Capital.

Stock Split

An increase in the number of shares of stock issued and outstanding, coupled with a proportionate reduction in the stock's par value. Total equity, assets, or liabilities do not change.

Classes of Stock

Common stock or preferred stock, and par value stock or no-par value stock

Treasury stock

Company owned stock that it has issued and later reacquired.

How is treasury stock recorded?

Contra account decreases Stockholder's equity and assets. It's recorded beneath the Retained Earnings account on the balance sheet as a negative amount.

Corporate Taxation

Corporations are separate taxable entities. They pay a variety of taxes not paid by sole proprietorships or partnerships. Corporate earnings are subject to double taxation to the extent they are distributed to shareholders in the form of dividends.

Continuous Life and Transferability of Ownership

Corporations have continuous lives despite changes in ownership. The transfer of stock does not affect the continuity of the corporation.

Organizing a Corporation

Creation begins when its incorporators obtain a charter from the state. The charter includes the authorization for the corporation to issue a certain number of stock.

No-par value stock

Does not have a par value per share but may have a stated value (an arbitrary amount assigned to it). Not as common.

Issuing Stock for Employee Compensation

Expenses are increased, capital stock is increased for the par value of the shares, and additional paid-in capital is increased for the difference.

Preferred stock

Gives its owners certain advantages such as receiving dividends and assets before the common stockholders. There are different classes of preferred stock (Class A and Class B or Series A and Series B) and each class is recorded in a separate account. Preferred stock is a hybrid between common stock and long-term debt. Preferred stock is rare.

Par value stock

Has an arbitrary amount assigned to each share when it's originally authorized by the corporate charter. Most states require companies to maintain a minimum amount of stockholders' equity called legal capital for the protection of creditors. (Most companies set the par value sometimes as low as 1 cent)

Return on Equity (ROE)

Measures profitability in comparison with just the shareholders' investment. ROA x Leverage Ratio = ROE

Cumulative Preferred Stock

Owners of this must receive all dividends in arrears plus the current year's dividend before any dividends go to the common stockholders. *in most states preferred stock is cumulative unless specifically labeled noncumulative

Resale of Treasury Stock

Reselling treasury stock grows a company's assets and stockholders' equity in the same exact way as issuing new stock does. A company never records gains or losses on transactions involving its own treasury stock. Amounts it receives in excess of the amounts originally paid are recorded as Paid-in Capital from Treasury Stock Transactions. It appears on the balance sheet, not the income statement.

Common Stock Issued for Services

Sometimes a corporation will issue shares of common stock in exchange for services rendered by employees or outsiders. In this case no cash is exchanged but the transaction is recognized at fair market value.

Limited Liability

Stockholders have no personal obligation for corporate liability. The most a stockholder can lose is the cost of the investment.

Separation of Ownership and Management

Stockholders own the corporation. The board of directors (elected by stockholders) appoints officers to manage the business. Without safeguards corporate officers might try to run the business for their own benefit and not for the benefit of stockholders. They might engage in fradulent financial reporting or misappropriate assets.

President

The COO in charge of day-to-day operations.

Common stock

The basic form of capital stock. Common stock owners are the owners of the corporation and stand to benefit the most if the corporation succeeds bc they take the most risk by investing.

Common Stock Issued for Assets Other Than Cash

The company records the assets received at their current market value and credits the Common Stock and Additional Paid-in Capital accounts accordingly.

Paid-in Capital in Excess of Par

The difference between the stock's issue price and par value. Ex: Stock issue price is $10 and par value is $0.05. The Paid-in Capital is $9.95

Authorized stock

The maximum number of shares the company can issue under its charter.

Earnings Per Share (EPS)

The net income attributable to each share of a company's outstanding common stock. It's a Key measure of a corporation's business success. Can be used to measure and compare profitability of companies of diff sizes in diff industries.

Outstanding stock

The number of shares that the stockholders own. Issued stock minus treasury stock.

Issued stock

The number of shares the company has issued to its stockholders. This is a cumulative total, less any shares permanently retired.

Where is paid-in capital listed?

The stockholders' equity section of the balance sheet immediately after the type of stock to which it relates.

Cash Dividends

To pay a dividend a company must have both 1) enough retained earnings to declare the dividend, and 2) enough cash to pay the dividend

Government Regulation

To protect a corporation's creditors and stockholders, both federal and state gov'ts monitor corporations. Regulations mainly ensure that corporations disclose info investors and creditors need to make informed decisions.

Trading on the Equity (Leverage)

Using bonds or other debt to increase a company's earnings per share of common stock

Chairperson

Usually the most powerful person in the organization and often has the title of CEO

Only the ___________ has the authority to declare a dividend.

board of directors

The incorporators:

pay fees, sign the charter, file documents with the state, and agree to a set of bylaws to act as the constitutions for governing the company.